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How the Income Tax Created the Modern Fiscal State

The 16th Amendment sought to balance fiscal and civic responsibilities. Source: General Records of the United States Government

Feb. 26 (Bloomberg) -- One hundred years ago this week,
U.S. Secretary of State Philander C. Knox presided over an
important step in the creation of the modern federal income tax.

By applying the Great Seal of the United States to the 16th
Amendment to the Constitution, Knox certified that the requisite
number of states had provided Congress with the “power to lay
and collect taxes on incomes from whatever source derived,
without apportionment among the several States and without
regard to any census or enumeration.”

The drive to enshrine the income tax in the Constitution
grew out of a protracted legal and political battle that should
help illuminate the budget showdowns now roiling Washington.

Almost two decades before the amendment was ratified, the
Supreme Court had struck down the 1894 law that instituted the
first peacetime national income tax. In a decision that shocked
most legal experts and social reformers, a slim majority of the
court in Pollock v. Farmers’ Loan & Trust Co. ruled that taxing
income violated the “direct tax clause.”

According to the Constitution, direct taxes needed to be
apportioned among the states based on population -- meaning that
a state’s population determined how much it owed in direct
taxes. Reversing almost a century of legal precedent, the court
ruled that because the 1894 tax wasn’t apportioned by population
it was unconstitutional.

‘Stepping Stone’

Many conservatives applauded the decision. For them, an
income tax was the first step toward class warfare and “creeping
socialism.” In his concurrence in Pollock, Justice Stephen J.
Field expressed the anxieties of many elites at the time. “The
present assault on capital is but the beginning,” he warned. “It
will be but the stepping-stone to others, larger and more
sweeping, till our political contests will become a war of the
poor against the rich; a war constantly growing in intensity and
bitterness.”

Field’s remarks came amid tremendous labor strife. And his
allusions to a war between the rich and poor fueled fears that
an income tax would hurl American society down the slippery
slope of socialist revolution. Yet progressive reformers turned
to an income tax not to radically redistribute wealth but to pay
for a modern industrial state in a fair and effective manner.

Before the income tax, the two main sources of federal
revenue were tariffs and excise taxes, both of which fell
disproportionately on the backs of ordinary Americans, and
neither of which could meet the growing demand for government
revenue. Reformers embraced a progressive income tax because it
solved both these problems.

To achieve their goals, progressives knew they had to
debunk the claims of creeping socialism. The Columbia University
political economist Edwin R.A. Seligman, a tax expert and a
leading public intellectual, took on the accusations. “The cry
of Socialism has always been the last refuge of those who wish
to clog the wheels of social progress or to prevent the
abolition of long-continued abuses,” he wrote. “The Factory Laws
were in their time dubbed socialistic. Compulsory education and
the public post office system were called socialistic. There is
scarcely a single tax which has ever been introduced, which has
not somewhere or other met with the same objection.” Yet despite
the pervasiveness and frequency of these claims, Seligman said,
“the argument nowhere carried any weight.”

The specter of socialism hanging over the income tax
gradually dissolved. The dramatic social dislocations wrought by
modern industrialism convinced many Americans of the need for an
activist state -- one that required increasing revenue. The
economic inequalities of the time likewise underscored the
regressive and ineffective nature of the existing tariff and
excise-tax regime. And when the Panic of 1907 triggered a deep
recession, reformers began calling once again for an income tax
to challenge the court’s ruling in Pollock.

‘Class Tax’

Eager to avert a showdown, the newly elected Republican
president, William Howard Taft, attempted to broker a peace by
proposing a constitutional amendment. With Southern and Western
states leading the way, support for the amendment gained
momentum. Within four years, the requisite number of states,
including several in the affluent Northeast, had ratified the
amendment, much to the surprise and chagrin of conservative
lawmakers who had given it little chance of success.

Congress soon began drafting a graduated income tax.
Southern and Western lawmakers led the way enacting a “class
tax,” with relatively high exemption levels and moderately
graduated rates, aimed squarely at the country’s wealthiest
citizens.

As Tennessee Representative Cordell Hull, one of the chief
architects of the new law, explained, the goal of the 1913
income tax was to ensure that the rich were paying their fair
share of increasing government expenses. “I have no disposition
to tax wealth unnecessarily or unjustly,” Hull said on the floor
of Congress, “but I do believe that the wealth of the country
should bear its just share of the burden of taxation and that it
should not be permitted to shirk that duty.” Hull intended the
income tax to counterbalance the regressive elements of the
existing regime. “Something is needed to restore the
equilibrium,” he said, “and that something can scarcely take any
form except that of an income tax.”

As we commemorate the centennial of the 16th Amendment and
look ahead to looming budgetary battles, we ought to keep in
mind that the foundations of our modern fiscal state are rooted
not in efforts to radically redistribute wealth, but in attempts
to balance fiscal duties and civic responsibilities. The
progressives who bequeathed this state to us certainly knew the
difference.

(Ajay K. Mehrotra is a professor of law and history at the
Maurer School of Law at Indiana University, Bloomington. He is
the author of “Sharing the Burden: Law, Politics, and the Making
of the Modern American Fiscal State, 1880-1930,” to be published
by Cambridge University Press. The opinions expressed are his
own.)